(June 29, 2011) — In violation of disclosure rules, the $13.9 Kentucky Retirement Systems (KRS) allegedly failed to disclose the use of placement agent activity in recent years.

However, according to a recent audit by Kentucky Auditor Crit Luallen, no evidence of “pay-to-play” activity at the scheme was found. Nevertheless, Luallen recommended 92 items for improving the system, urging greater oversight. The Kentucky retirement system’s audit is now proceeding to the US Securities and Exchange Commission (SEC).

Luallen’s staff spent months probing into the role of placement agents, and found nearly $11.6 million in fees paid or committed to placement agents from 2007 to 2010. The report discovered that New York placement agent Glen Sergeon had “an unusually close working relationship” with Adam Tosh — the former chief investment officer at KRS and the current managing director at consulting firm Rogerscasey. Sergeon was involved in seven of 13 of the system’s investment agreements in which placement agents were used in 2008 and 2009. Additionally, the audit discovered that Sergeon “appears to have acted as a representative of KRS, setting up appointments and making travel arrangements” for Tosh.

“Based on the information they reviewed, auditors saw no evidence of a ‘pay to play’ scheme involving placement agents, or of conflicts of interest that benefited KRS officials; nor is there evidence that KRS incurred any additional cost through the use of placement agents,” Luallen said in a press release accompanying the audit. “However, the audit points to several troubling aspects regarding the use of placement agents and will be referred to the US Securities and Exchange Commission (SEC). The SEC has the authority to determine if further investigation is needed in Kentucky.”

Luallen continued: “There is not another public agency in Kentucky that has such a significant fiduciary responsibility affecting as great a number of people as the Kentucky Retirement System’s Board. To carry out this responsibility, these Board Trustees need to be highly qualified, adequately informed and fully engaged. Our recommendations offer significant steps KRS can take to strengthen Board governance.”

The board of trustees at KRS requested the audit after concerns were raised over how some placement agents were selected. In August 2010, the SEC opened an “informal inquiry” into KRS’ use of placement agents, Chris Tobe, a member of the KRS board and investment committee, told aiCIO. Despite such apparent potential conflicts, Luallen said, “We followed up every issue that was raised and could not substantiate any specific evidence of wrongdoing.”

Responding to the audit findings, KRS board Chairwoman Jennifer Elliot said in a news release that the board is “heartened by the fact that there were no findings of significant wrongdoing, excessive spending or other systemic problems.”

Whileplacement agent activity is not illegal, recent scandals involving public employee pension funds around the country have placed a spotlight on the industry, leading many funds to reassess their relationships. Worries about lack of disclosure in the pension fund community exploded last year when a pension-fund scandal in New York exposed the role of placement agents in bribery and corruption charges. In May 2010, California’s attorney general filed a civil lawsuit that alleged California Public Employees’ Retirement System (CalPERS) officials — Fred Buenrostro, a former chief executive, and Alfred Villalobos, former board member turned placement agent — participated in a scheme to obtain business for investment firms, providing pension officials with luxury trips and other gifts.

In March, CalPERS issued a report detailing the use of placement agents and highlighting that there may have been influence peddling by a former CEO, Board members, and investment staff.

Following last year’s investigation of the $140.6 billion (as of December 31, 2010) New York State Common Retirement Fund (CRF) and other major pension funds that revealed the role of middlemen, the SEC has stepped up its regulation of placement agents.